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78
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our earnings and financial position are exposed to financial market risk, including those resulting from changes
in interest rates.
The level of our pretax earnings is subject to market risk due to changes in interest rates and the resulting impact
on investment income and interest expense. Prior to 2009, under interest rate swap agreements, we exchanged the fixed
interest rate under all of our senior notes for a variable interest rate based on LIBOR using interest rate swap agreements.
We terminated all of our interest rate swap agreements in 2008. We may re-enter into interest rate swap agreements in
the future depending on market conditions and other factors. Amounts borrowed under the revolving credit portion of
our $1.0 billion unsecured revolving credit agreement bear interest at either LIBOR plus a spread or the base rate plus
a spread. There were no borrowings outstanding under our credit agreement at December 31, 2014 or December 31,
2013.
Interest rate risk also represents a market risk factor affecting our consolidated financial position due to our
significant investment portfolio, consisting primarily of fixed maturity securities of investment-grade quality with a
weighted average S&P credit rating of AA- at December 31, 2014. Our net unrealized position increased $225 million
from a net unrealized gain position of $250 million at December 31, 2013 to a net unrealized gain position of $475
million at December 31, 2014. At December 31, 2014, we had gross unrealized losses of $41 million on our investment
portfolio primarily due to an increase in market interest rates in the current markets than when the securities were
purchased, and as such, there were no material other-than-temporary impairments during 2014. While we believe that
these impairments are temporary and we currently do not have the intent to sell such securities, given the current market
conditions and the significant judgments involved, there is a continuing risk that future declines in fair value may occur
and material realized losses from sales or other-than-temporary impairments may be recorded in future periods.
Duration is the time-weighted average of the present value of the bond portfolio’s cash flow. Duration is indicative
of the relationship between changes in fair value and changes in interest rates, providing a general indication of the
sensitivity of the fair values of our fixed maturity securities to changes in interest rates. However, actual fair values
may differ significantly from estimates based on duration. The average duration of our investment portfolio, including
cash and cash equivalents, was approximately 4.1 years as of December 31, 2014 and 4.3 years as of December 31,
2013. Based on the duration including cash equivalents, a 1% increase in interest rates would generally decrease the
fair value of our securities by approximately $466 million.
We have also evaluated the impact on our investment income and interest expense resulting from a hypothetical
change in interest rates of 100, 200, and 300 basis points over the next twelve-month period, as reflected in the following
table. The evaluation was based on our investment portfolio and our outstanding indebtedness at December 31, 2014
and 2013. Our investment portfolio consists of cash, cash equivalents, and investment securities. The modeling technique
used to calculate the pro forma net change in pretax earnings considered the cash flows related to fixed income
investments and debt, which are subject to interest rate changes during a prospective twelve-month period. This
evaluation measures parallel shifts in interest rates and may not account for certain unpredictable events that may affect
interest income, including unexpected changes of cash flows into and out of the portfolio, changes in the asset allocation,
including shifts between taxable and tax-exempt securities, and spread changes specific to various investment categories.
In the past ten years, changes in 3 month LIBOR rates during the year have exceeded 300 basis points once, have not
changed between 200 and 300 basis points, have changed between 100 and 200 basis points three times, and have
changed by less than 100 basis points six times.